Commentary: Internet bubble burst 13 years ago

CHAPEL HILL, N.C. (MarketWatch) — When I mentioned “anniversary” in this column’s headline, I’ll bet you thought that I was referring to the fourth birthday of the bull market, celebrations of which are already underway.

But I’m not.

I’m referring instead to what I think is a far more momentous, yet less appreciated, anniversary: the 13th anniversary of the bursting of the Internet bubble — which will be “celebrated,” ironically enough, on almost the same day as the bull market’s fourth birthday. So I will let everyone else break out the bubbly to celebrate the bull market’s longevity, and focus this column on the disaster that began 13 years ago.

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And I’m not being hyperbolic in saying that it was disastrous. Even though everyone else is preparing the celebrate the four-year-old bull, the Nasdaq Composite
COMP, -0.01%
is still some 38% below its all-time high of 5,132.50, which was hit on March 10, 2000. In inflation-adjusted terms, this market average is more than 53% off its March 2000 high.

No other bear market in U.S. stock-market history has been as awful as the Nasdaq’s since 2000.

Weren’t the 1930s even worse? Didn’t it take 25 years for the Dow Jones Industrial Average
DJIA, -0.32%
to surpass its 1929 pre-crash level?

No, to the first question. Yes, to the second.

The Dow paints an unfairly awful picture. The reality was far less bad, once you take into account a more diversified market index, dividends and inflation.

In fact, according to Ibbotson Associates, a division of Morningstar, the inflation-adjusted total return index of the U.S. stock market was in late 1936 just as high as it was at its pre-crash peak in 1929. That was less than eight years later.

Nothing to celebrate, to be sure, but not nearly as bad as what the Nasdaq has experienced.

What about the 16-year period between January 1966 and October 1982? Wasn’t the Dow at the end of this 16-year period at the same level (1,000) that it was at the beginning — and far lower in inflation-adjusted terms?

Yes, but once again the Dow paints a distorted picture — for all the same reasons as in the 1930s. According to Ibbotson, the inflation-adjusted total return index of the U.S. market was higher at the end of 1972 than it was in January 1966. And by mid-1983 that index was higher still — 10 ½ years later.

The Nasdaq’s 13-year bear market still comes out as far worse — and by an order of magnitude, or more.

Would a better analogy be the Japanese bear market that began more than 20 years ago? After all, the Nikkei 225 index
NIK, +0.30%
has never come close to returning to its 1989 peak of nearly 40,000, for example. It languishes today at just over the 11,000 level.

Yet, again, the full picture is not that bad. When I used the Japanese wholesale price index to adjust the MSCI Japan Total-Market Total-Return dollar-denominated index, I found that the Japanese stock market was higher in March 2000 than it was at its 1989 peak.

Once again the Nasdaq’s bear market comes out on the bad end of the comparison.

What lessons can we draw from the sobering picture painted by the Nasdaq Composite over the last 13 years? I think there are three major ones:

Diversification is crucial. Broadly diversified indexes recover far more quickly from bear markets than do narrowly defined subsets — whether that subset is the Dow, with just 30 stocks, or the Nasdaq Composite, which is dominated by a relatively small number of large-cap companies. Anyone who put all their money into the Nasdaq Composite in March 2000 was putting far too many eggs in the baskets of a few companies, like Cisco
CSCO, +0.42%
which at the time dominated the index just as Apple
AAPL, -0.87%
does (or at least did) today.

Dividends play a crucial role in stocks’ long-term returns — so don’t ignore them. Believe it or not, dividends accounted for about half of stocks’ total return over the last century.

Inflation must be taken into account in any historical comparison. A focus on nominal prices during periods of inflation creates the false impression that we’re doing better than we really are — just as such a focus during periods of deflation makes it look like we’re doing worse. (Economists refer to these false impressions as “money illusion.”) While the impact of this illusion can be quite small over shorter periods of time, it can be — and usually is — huge over longer periods.

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